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Chapter 11
Performance Measurement in Decentralized
Organizations
Solutions to Questions
11-1 In a decentralized organization, decision-making authority isn’t confined to a few top executives;
instead, decision-making authority is spread throughout the organization.
11-2 The benefits of decentralization include: (1) by delegating day-to-day problem solving to lower-
level managers, top management can concentrate on bigger issues such as overall strategy; (2)
empowering lower-level managers to make decisions puts decision-making authority in the hands of
those who tend to have the most detailed and up-to-date information about day-to-day operations; (3)
by eliminating layers of decision-making and approvals, organizations can respond more quickly to
customers and to changes in the operating environment; (4) granting decision-making authority helps
train lower-level managers for higher-level positions; and (5) empowering lower-level managers to make
decisions can increase their motivation and job satisfaction.
11-3 The manager of a cost center has control over cost, but not revenue or the use of investment
funds. A profit center manager has control over both cost and revenue. An investment center manager
has control over cost and revenue and the use of investment funds.
11-4 Margin is the ratio of net operating income to total sales. Turnover is the ratio of total sales to
average operating assets. The product of the two numbers is the ROI.
11-5 Residual income is the net operating income an investment center earns above the company’s
minimum required rate of return on operating assets.
11-6 If ROI is used to evaluate performance, a manager of an investment center may reject a
profitable investment opportunity whose rate of return exceeds the company’s required rate of return but
whose rate of return is less than the investment center’s current ROI. The residual income approach
overcomes this problem because any project whose rate of return exceeds the company’s minimum
required rate of return will result in an increase in residual income.
11-7 The difference between delivery cycle time and throughput time is the waiting period between
when an order is received and when production on the order is started. Throughput time is made up of
process time, inspection time, move time, and queue time. Process time is value-added time and
inspection time, move time, and queue time are non-value-added time.
11-8 An MCE of less than 1 means that the production process includes non-value-added time. An
MCE of 0.40, for example, means that 40% of throughput time consists of actual processing, and that the
other 60% consists of
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Chapter 11 Performance Measurement in Decentralized Organizations
11-9 A company’s balanced scorecard should be derived from and support its strategy. Because
different companies have different strategies, their balanced scorecards should be different.
11-10 The balanced scorecard is constructed to support the company’s strategy, which is a theory
about what actions will further the company’s goals. Assuming that the company has financial goals,
measures of financial performance must be included in the balanced scorecard as a check on the reality
of the theory. If the internal business processes improve, but the financial outcomes do not improve, the
theory may be flawed and the strategy should be changed.
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Chapter 11 Performance Measurement in Decentralized Organizations
2. Sales
Turnover =
Average operating assets
$18,000,000
= = 0.5
$36,000,000
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3. If the MCE is 35%, then 35% of throughput time was spent in value-
added activities, the other 65% was spent in non-value-added activities.
5. If all queue time is eliminated, then the throughput time drops to only 4
days (0.5 + 2.8 + 0.7). The MCE becomes:
Value-added time 2.8 days
MCE= = =0.70
Throughput time 4.0 days
Thus, the MCE increases to 70%. This exercise shows quite dramatically
how lean production approach can improve operations and reduce
throughput time.
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Financial
Sales + Contribution +
margin per ton
Customer
Number of new +
customers acquired
Internal
Business
Processes Number of different +
paper grades produced
Learning
and Growth Number of employees
trained to support the +
flexibility strategy
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Chapter 11 Performance Measurement in Decentralized Organizations
product diversity, smaller batch sizes, and more frequent shipments. The
fact that each of the hypotheses mentioned above can be questioned
does not invalidate the balanced scorecard. If the scorecard is used
correctly, management will be able to identify which, if any, of the
hypotheses are invalid and modify the balanced scorecard accordingly.
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Chapter 11 Performance Measurement in Decentralized Organizations
1. (b) (c)
Net Average
(a) Operating Operating ROI
Sales Income* Assets (b) ÷ (c)
$4,500,000 $290,000 $800,000 36.25%
$4,600,000 $300,000 $800,000 37.50%
$4,700,000 $310,000 $800,000 38.75%
$4,800,000 $320,000 $800,000 40.00%
$4,900,000 $330,000 $800,000 41.25%
$5,000,000 $340,000 $800,000 42.50%
*Sales × Contribution Margin Ratio – Fixed Expenses
2. The ROI increases by 1.25% for each $100,000 increase in sales. This
happens because each $100,000 increase in sales brings in an additional
profit of $10,000. When this additional profit is divided by the average
operating assets of $800,000, the result is an increase in the company’s
ROI of 1.25%.
Increase in sales.................................................... $100,000 (a)
Contribution margin ratio....................................... 10% (b)
Increase in contribution margin and net operating
income (a) × (b)................................................. $10,000 (c)
Average operating assets....................................... $800,000 (d)
Increase in return on investment (c) ÷ (d).............. 1.25%
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$8,000,000
= = 2.5
$3,200,000
ROI = Margin × Turnover
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Chapter 11 Performance Measurement in Decentralized Organizations
$4,000,000
= = 20%
$20,000,000
Sales
Turnover =
Average operating assets
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$8,000,000 + $2,000,000
=
$3,200,000 + $800,000
$10,000,000
= = 2.5
$4,000,000
ROI = Margin × Turnover
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2. Perth Darwin
Average operating assets.................... $3,000,000 $10,000,000
Net operating income......................... $630,000 $1,800,000
Minimum required return on average
operating assets—16% × Average
operating assets.............................. 480,000 1,600,000
Residual income................................. $150,000 $ 200,000
3. No, the Darwin Division is simply larger than the Perth Division and for
this reason one would expect that it would have a greater amount of
residual income. Residual income can’t be used to compare the
performance of divisions of different sizes. Larger divisions will almost
always look better. In fact, in the case above, Darwin does not appear
to be as well managed as Perth. Note from Part (1) that Darwin has only
an 18% ROI as compared to 21% for Perth.
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2. The manager of the Western Division seems to be doing the better job.
Although her margin is three percentage points lower than the margin
of the Eastern Division, her turnover is higher (a turnover of 3.5, as
compared to a turnover of two for the Eastern Division). The greater
turnover more than offsets the lower margin, resulting in a 21% ROI, as
compared to an 18% ROI for the other division.
Notice that if you look at margin alone, then the Eastern Division
appears to be the strongest division. This fact underscores the
importance of looking at turnover as well as at margin in evaluating
performance in an investment center.
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Customer
Number of new +
customers acquired
Internal Business
Processes Average number of –
errors per tax return
Learning
And Growth
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° If revenue per employee and sales increase, then the profit margin
should increase.
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$800,000
= =8
$100,000
ROI = Margin × Turnover
= 2% × 8 = 16%
$800,000 + $80,000
=
$100,000
$880,000
= = 8.8
$100,000
ROI = Margin × Turnover
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Chapter 11 Performance Measurement in Decentralized Organizations
$800,000
= =8
$100,000
ROI = Margin × Turnover
= 2.4% × 8 = 19.2%
$800,000
=
$100,000 - $20,000
$800,000
= = 10
$80,000
ROI = Margin × Turnover
= 2% × 10 = 20%
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Chapter 11 Performance Measurement in Decentralized Organizations
Division
Fab Consulting IT
Sales....................................... $800,000 * $650,000 $500,000
Net operating income............... $72,000 * $26,000 $40,000 *
Average operating assets......... $400,000 $130,000 * $200,000
Margin..................................... 9% 4% * 8% *
Turnover................................. 2.0 5.0 * 2.5
Return on investment (ROI)...... 18% * 20% 20% *
*Given.
Note that the Consulting and IT Divisions apparently have different
strategies to obtain the same 20% return. The Consulting Division has a
low margin and a high turnover, whereas the IT Division has just the
opposite.
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Chapter 11 Performance Measurement in Decentralized Organizations
2. Fred Halloway will be inclined to reject the new product line because
accepting it would reduce his division’s overall rate of return.
3. The new product line promises an ROI of 21%, whereas the company’s
overall ROI last year was only 18%. Thus, adding the new line would
increase the company’s overall ROI.
4.
a. Present New Line Total
Operating assets...................... $5,250,000 $3,000,000 $8,250,000
Minimum required return.......... × 15% × 15% × 15%
Minimum net operating income. $787,500 $450,000 $1,237,500
Actual net operating income..... $1,680,000 $ 630,000 $2,310,000
Minimum net operating income
(above)................................. 787,500 450,000 1,237,500
Residual income....................... $ 892,500 $ 180,000 $1,072,500
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to accept the new product line because adding the product line would
increase the total amount of his division’s residual income, as shown
above.
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that the analyst should look carefully at Company B’s investment. Is the
company keeping an inventory larger than necessary for its sales
volume? Are receivables being collected promptly? Or did Company A
acquire its fixed assets at a price level which was much lower than that
at which Company B purchased its plant?”
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Sales +
Customer
Customer Customer
satisfaction with + satisfaction with +
service menu choices
Internal
Business Dining area Average time
Processes cleanliness
+ to prepare an –
order
Average time Number of
to take orders – menu items
+
Learning
and Percentage Percentage
Growth of dining of kitchen
room staff + staff +
completing completing
hospitality cooking
course course
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$1,880,000 + $1,920,000
Average operating assets = = $1,900,000
2
Net operating income
Margin =
Sales
$627,000
= = 15%
$4,180,000
Sales
Turnover =
Average operating assets
$4,180,000
= = 2.2
$1,900,000
ROI = Margin × Turnover
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Chapter 11 Performance Measurement in Decentralized Organizations
3. In real life, the production manager simply added several weeks to the
delivery cycle time. In other words, instead of promising to deliver an
order in four weeks, the manager promised to deliver in six weeks. This
increase in delivery cycle time did not, of course, please customers and
drove some business away, but it dramatically improved the percentage
of orders delivered on time.
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$80,000 $1,000,000
= ×
$1,000,000 $500,000
= 8% × 2 = 16%
2. $90,000 $1,000,000
ROI = ×
$1,000,000 $500,000
= 9% × 2 = 18%
(Increase) (Unchanged) (Increase)
3. $80,000 $1,000,000
ROI = ×
$1,000,000 $400,000
= 8% × 2.5 = 20%
(Unchanged) (Increase) (Increase)
4. The company has a contribution margin ratio of 40% ($20 CM per unit
divided by $50 selling price per unit). Therefore, a $100,000 increase in
sales would result in a new net operating income of:
Sales..................................... $1,100,000 100%
Variable expenses.................. 660,000 60%
Contribution margin............... 440,000 40%
Fixed expenses...................... 320,000
Net operating income............. $ 120,000
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Chapter 11 Performance Measurement in Decentralized Organizations
$120,000 $1,100,000
ROI = ×
$1,100,000 $500,000
= 10.91% × 2.2 = 24%
(Increase) (Increase) (Increase)
6. $80,000 $1,000,000
ROI = ×
$1,000,000 $320,000
= 8% × 3.125 = 25%
(Unchanged) (Increase) (Increase)
7. $60,000 $1,000,000
ROI = ×
$1,000,000 $480,000
= 6% × 2.08 = 12.5%
(Decrease) (Increase) (Decrease)
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Applied Pharmaceuticals
Financial
Return on +
Stockholders’ Equity
Customer
Internal
Business R&D Yield + Defect rates –
Processes
Learning
and Percentage of job +
Growth offers accepted
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Chapter 11 Performance Measurement in Decentralized Organizations
Financial
Sales +
Customer
+
Number of repeat customers
Internal
Business Room cleanliness +
Processes
Learning
and Employee Employee morale +
Growth –
turnover as shown in
survey
Number of employees +
receiving database
training
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3. a. and b.
Month
5 6
Throughput time in days:
Process time........................................... 0.6 0.6
Inspection time...................................... 0.8 0.0
Move time.............................................. 1.4 1.4
Queue time............................................ 0.0 0.0
Total throughput time............................. 2.8 2.0
Manufacturing cycle efficiency (MCE):
Process time ÷ Throughput time............. 21.4% 30.0%
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Chapter 11 Performance Measurement in Decentralized Organizations
Financial
Total profit +
Learning
Percentage of sales
and
clerks trained to
Growth
correctly enter data +
on charge account
slips
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